Ask these questions before choosing your business structure
Whether you have already built your own profitable business or you are just starting to put into motion a great idea for a new one, the proper business structure can help you avoid unnecessary pitfalls and assist you down the path of success. Which business structure is right for you? Sole proprietorship, partnership, limited liability company, S corporation or C corporation? Unfortunately, the answer may be elusive. Like all business decisions, choosing the right structure requires a careful weighing of the costs and benefits associated with each form.
By following the proper steps and seeking guidance from a qualified attorney, the decision may become clearer. Below we list four steps that will help guide you through the process of finding the right structure for your business.
1. Determine your liabilities
What you sell or what service you provide may be the most important factor in determining the type of business structure you choose. Are you providing a service that may pose a risk to others? Are you selling a product that could potentially be dangerous? If that's the case, a sole proprietorship or partnership is not the right choice. While these two business forms are the simplest and offer the greatest flexibility, they are not considered separate legal entities and offer no protection to their owners from liabilities that the business may create. Furthermore, under general partnerships, one partner may be liable for the other's poor decisions. On the other hand, limited liability companies (LLCs) and corporations, if properly established and maintained, can provide their owners significant protection from the company's debts and liabilities.
2. Estimate your tax liabilities
The profitability of a company and the tax liabilities it will incur should weigh heavily when you consider what form your business should take. Sole proprietorships, partnerships and LLCs all have pass-through taxation. This means that the business itself is not taxed but rather all income and expenses from the business flow through to the owners' tax returns. While this may be advantageous in some cases, the high rate of self-employment tax (contributions to Medicare and Social Security) on these types of entities may prove burdensome. S corporations allow for business owners to take a reasonable salary that is subject to the self-employment tax, while also allowing the pass through of the company's net income that is not taxed in this manner. LLCs may be treated as S corporations for tax purposes if the proper elections are made. C corporations are open to a double taxation where a corporation's profits are taxed and distributions to the shareholders in the form of dividends are also taxed.
3. Consider how flexible your business must be
How quickly your company's needs change and who will make important decisions are factors that should be considered. A sole proprietor has complete control of his or her business. An LLC's operating agreement can be tailored to meet the specific needs of the company and can be drafted in such a way that all members take an active role in running the business. Corporations, although often considered less flexible than other business forms, may provide a level of stability that could attract outside investors or make changes in ownership less complicated.
4. Be prepared to change
Although the decision you make now can help your business grow and avoid unnecessary costs and liabilities, remember that over time your company's needs may change. Whenever you are considering the future of your company, ask yourself: Have my tax liabilities changed? Are we now selling products or providing services that put my personal assets at a higher risk? Do we need new capital to expand or should we bring on new owners?
Remember, once you choose the structure for your business, the choice is not set in stone. With the proper guidance from a qualified attorney and tax professional, your business structure can change to fit the dynamic needs of your business.
Christopher Wright, an attorney at the Augusta law firm Lipman & Katz, handles complex probate concerns, litigation matters and business transactions. He can be reached at cwright@lipmankatz.com
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